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A Truly Momentous Event

The ten-year has breached three percent
A truly momentous event
The dollar is gaining
While stocks take a caning
For bulls now there’s much discontent

Does a 3.00% yield in the 10-year Treasury really matter that much? While a cursory look at the market reaction yesterday would indicate it does, it is not clear to me this is the case.

Ten-year Treasury yields traded through 3.00% for the first time since January 2014 in yesterday’s session, and coincidentally the US equity market fell pretty sharply. However, upon closer inspection the proximate cause of the equity decline seems to have been a comment from a bellwether US manufacturing company on their earnings call, where the CFO indicated that Q1 earnings were likely to be the “high-water mark for the year.” Despite very strong results, that stock fell sharply. Markets that are priced for perfection, similar to the US equity market overall, cannot accept that type of information without repricing, and so that is what we saw. The key concern seems to be that despite the widely touted global growth environment, this company feels the future is less bright than had been expected. Part of the reason is that input prices continue to rise rapidly and are cutting into margins. And part of the reason seems to be a concern that perhaps the global growth story is not as robust as had been expected earlier in the year. In the end, the combination of events was too much for the US stock market and we saw some pretty sharp declines that have carried over around the world.

Interestingly, the dollar, which had been benefitting for the past week as US yields rose, also fell slightly in the session. This is a bit of a head scratcher, as it appeared that the historic cyclical relationship between the dollar and US rates was reasserting itself. And while the decline was modest, just 0.3%, it was strange nonetheless. However, this morning things are back on track with the dollar recouping yesterday’s entire decline and, quite frankly, looking like it has further to run.

So what are we to make of these new milestones in the market? Regarding the Treasury story, 3.00% represents a big psychological point, but probably not a key economic one. Traders and investors tend to over emphasize round numbers (recall when the Dow was approaching 25,000, or USDJPY at 100.00) but it is not clear that a round number is actually significant in the workings of the economy. When it comes to financing operations, it is the rare company where a 10bp change is the difference between making it and failing. And quite frankly if that is the case, the company is going to fail anyway. But the psychology does matter as it helps inform confidence in the market and the economy overall. So I wouldn’t dismiss this as unimportant, but it’s probably not the most important thing happening. Rather, that would be the ongoing economic story and how the data that we continue to see plays out.

In that vein, the relative data releases between the US and the rest of the world are far more interesting. And those continue to point to the US outperforming for the time being. Even though recent US data has been mixed (e.g. Retail Sales soft, housing strong) that has been a far better result than the consistently soft data coming from the Eurozone, the UK, Japan and most of the rest of the developed world. This is especially true regarding inflation, where the trajectory in the US is unambiguously pointing higher while we continue to see misses to the downside elsewhere. And it is this point that is likely to inform policy actions going forward.

There is one other spin to note of late, and that is the commentary I read has highlighted relatively hawkish comments made by ECB, BOE and BOJ members, even though they were made last month before the latest set of data added to the impression of slowing growth momentum. At the same time, I keep reading that the Fedspeak we have been hearing is actually NOT that hawkish, despite a near universal discussion of the need to keep ahead of the inflation situation and not allow the economy to run too hot. If I didn’t know better, I might think that the journalists who are writing the articles were trying to drive the narrative themselves rather than report the news. But then that could never happen, could it?

At any rate, my read continues to be that the Fed will remain on course to tighten policy further this year, with at least three more rate hikes coming, and that we will continue to see a more dovish policy response elsewhere as the growth story falters.

As to the overnight session, the dollar, as mentioned above, has recouped all of yesterday’s losses and currently sits higher by 0.35% vs. the euro, 0.25% vs. the pound and 0.35% vs. the yen. In fact, the entire G10 is down by similar amounts. We are also seeing that price action throughout the EMG bloc, where the notably movers are MXN (-1.4%), RUB (-0.75%) and ZAR (-1.3%). In Mexico, not only have oil prices ebbed, but there is increasing concern that AMLO is going to win the presidential election in July and that with him, policies are going to become far less business friendly. He is, after all, a far left wing populist firebrand, and while he may have moderated his tone on renationalizing assets, he is still focused on unwinding labor and energy investment policies that have been very beneficial to the country. One other currency of note has continued its recent decline, the Chinese renminbi, which is down 0.5% overnight and 1.5% from its nadir at the end of March. The word out of Beijing has altered to include additional policy support while ceasing to discuss excess leverage. This was always going to be an issue there, as the idea of reducing leverage without tightening policy and slowing economic growth held some key contradictions. Apparently, despite President Xi being the supreme ruler in China, the laws of economics are too great for even his powers to repeal.

And that’s really it for the day. Equity futures are currently pointing lower, Treasuries remain under pressure with the 10-year yield now at 3.03%, and commodities are under the gun as well. All of that points to continued strength in the dollar and I see no reason why that shouldn’t continue. As I have mentioned before, I expect the euro to test the bottom of its trading range, which at 1.2155 is a scant 20 pips from the current level. Typically it won’t break on the first test, but by the end of the month, don’t be surprised to see 1.2000 on a screen near you.